The aim was to make rupees more expensive in the domestic market, effectively raising interest rates and trying to stem a decline in the currency at a time when funds are flowing out of emerging markets.

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The RBI’s headquarters in Mumbai

But it didn’t stop the currency’s drop: since then the rupee has fallen to almost daily record lows, touching a fresh bottom of 64.11 to the U.S. dollar on Tuesday.

So late Tuesday, the central bank changed course. Or, dare we say, flip-flopped?

The RBI said it would repurchase on Friday about $1.26 billion in long-term rupee currency bonds, pumping liquidity back into the market, and effectively bringing interest rates down.

The first move, six weeks ago, signaled the bank was focused foremost on stemming a currency decline and fighting the inflation that a weakening currency stokes. Keeping inflation in check – also known as price stability — is the central bank’s primary mandate. But the move not only failed to stem the rupee’s slide but risked further hurting the country’s already-weak economic growth outlook.

India’s economic woes have been building for a couple of years and its recent currency problems once again drew investor attention to its imbalances. The nation imports much more than it exports, making it reliant on capital inflows to fill the gap. An outflow from local stocks and bonds has exacerbated the problem.

So now the RBI’s policy appears to be headed in a new direction, one much more closely associated with trying to boost economic growth by limiting interest rate hikes.

Taimur Baig, an economist with Deutsche Bank in Singapore, says the move begs the question, “Are they giving up on the rupee in order to cap interest rates?”

It may be too soon to tell whether the new course will do any better at fixing India’s currency and economic problems. A stronger economy in theory will attract fund inflows, aiding the local currency. The rupee early Wednesday recovered somewhat to 63.34 to the dollar.

But some economists contend that the shift in direction has already been unhelpful in one way: by adding another mixed signal to what they view as a series of piecemeal measures in recent weeks that don’t add up to what could be considered a coordinated plan.

These include raising taxes on gold and silver to slow imports, sourcing more oil from Iran via a barter system – reducing the need to buy dollars. The RBI even imposed quasi- capital controls such as limiting the amount of money Indian companies and residents can send abroad.

Part of the issue is that India’s Finance Ministry favors lower rates to boost growth, while the central bank has been concerned about stemming rupee weakness and near-double-digit consumer inflation.

The imminent move of Raghuram Rajan, a former chief economist of the International Monetary Fund, to head the central bank may change this dynamic.

He starts on Sept. 4, when current governor, Duvvuri Subbarao’s term ends. Mr. Subbarao has been especially reluctant to cut interest rates.
Barclays, in a note Wednesday, said the “central bank’s relatively quick reversal will not enhance its long-term credibility.”

Still, the bank, like some other observers, said the move was a “welcome near-term correction in course.”

That’s because India’s growth, at around 5% annually, is already at multiple-year lows and far off recent rates of 9%. If growth falls further, that would add to foreign investor jitters. (Barclays points out that foreign institutional investors have around $200 billion in Indian equities.)

DBS also saw the shift as helpful as it will support government bond prices, a majority of which are held by local commercial banks.

None of this, of course, actually gets to the root of the overall problem, some economists point out.

What really needs to be done is not monetary-policy tinkering by the central bank but dramatic broader reforms pushed by the government.

For starters, the government could overhaul Byzantine rules to make it more attractive for foreigners to make physical investments in India. But that won’t happen overnight.

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